Understand business performance by using financial analysis.
Why is information from both the income statement and balance sheet useful as a comparison performance measure?
As a performance measure for comparing company performance, it is useful to know how much profit is generated for each $100 of capital invested in the balance sheet.
Example: There are two businesses producing similar products and services. They both make the same profit, $1m per annum. Business A has $3m invested in the balance sheet (in working capital, fixed and other assets). Business B has $2m invested in the balance sheet. Which is the better business?
When businesses are similar, then the more efficient business is usually the one that has the smaller balance sheet.
For each $100 invested in the balance sheet, Business A produces $33 profit. Business B produces $50 profit.
If one were comparing this performance measure, then Business B is the better performer.
On the other hand, if the purchase price for Business A were cheaper, then A could be a good investment, as the new owners will know that they can get the balance sheet in order to improve the financial outcome.
All companies and businesses should be on top of their financials. There are software tools like Strategic Focus to help with performance measures such as NOPAT. It calculates business performance and does detailed financial analysis. It can also suggest areas that need to be improved.